Quantitative Techniques for Competition and Antitrust Analysis by Peter Davis and Eliana Garcés_15 pptx

10.1. Rationales for Vertical Restraints and Integration 513 10.1.3.1 Territorial Restrictions Territorial restrictions are normally used to reduce intrabrand competition down- stream. When sales and service efforts by the retailer are important to the manufac- turer, they will want to ensure that retailers reap the rewards of their investments in service quality. By granting exclusive rights of sale in a given territory to a single retailer or a group of retailers, the manufacturer can ensure that retailers in different areas do not free ride on each other’s investment. By eliminating the capacity to attract shoppers from other territories, the horizontal pricing externality, whereby retailers hurtthe manufacturer by lowering prices to steal customers from each other, is also removed. It is, of course, essential for this practice to have the desired effect that arbitrage opportunities are eliminated. That said, exclusive territories actively prevent competition between retailers and therefore may clearly potentially have important anticompetitive consequences. Indeed, it is exactly the “horizontal pric- ing externality” which competition authorities usually fight very hard to protect precisely because it results in low prices for consumers. In an extreme case, with a monopoly manufacturer and a set of retailers who, absent the territorial restrictions, would otherwise compete, territorial restrictions could enforce a market division arrangement entirely equivalent to explicit collusion between the retailers. To eval- uate such a policy we may need to evaluate the way in which consumers trade off potentially higher prices for goods against any higher quality of service provided. Territorial restrictions as described above have been a tradition in the car sales sec- tor in Europe, where markets were traditionally defined as national, with a distribu- tion system characterized by exclusive dealing and geographic restrictions, including a restriction by manufactures of cross-border sales. In 2002, the European Commis- sion concluded that exclusive dealing agreements between car manufacturers and car dealers as well as the exclusive sales territories granted by the manufacturers to the dealers were not justified on grounds of efficiency as the consumers were “not getting a fair share of the resulting benefits.” 12 The European Commission issued new conditions for the sale of cars in the European Union notably imposing the right of exclusive dealers to sell to operators outside of the manufacturer’s official network. 13 10.1.3.2 Resale Price Maintenance: Minimum Price An alternative way to induce retailers to provide the level of services, sales effort, or advertisement that is optimal for the manufacturer is to establish a minimum sales price thereby restricting price competition. Firms could, for example, simply refuse 12 “Commission adopts comprehensive reform of competition rules for car sales and servicing” IP/02/1073 of 17/07/2002 available at http://europa.eu/rapid/pressReleasesAction.do?reference=IP/02/ 1073&format=HTML&aged=0&language=EN&guiLanguage=en. 13 Commission Regulation (EC) no. 1400/2002 of July 31, 2002 on the application of Article 81(3) of the Treaty to categories of vertical agreements and concerted practices in the motor vehicle sector. 514 10. Quantitative Assessment of Vertical Restraints and Integration to sell to retailers who charge a retail price below an established minimum. For instance, in the second half of the 1990s, music recording companies in the United States allegedly notified music retailers that, if they advertised music CDs at a price less than a stipulated amount, the recording companies would withdraw the financial support for advertisement and sales that they usually granted to those retailers. Those advertisement and promotion payments were an important source of revenue for retailers and the rule was alleged as a de factoestablishment ofa pricefloor, triggering a multidistrict class action by purchasers of prerecorded music against the music majors. 14 Because resale price maintenance can also facilitate collusive agreements and was, until the Leegin 15 decision, a per se offense in the United States, the recording companies allegedly tried to circumvent the antitrust statutes by penalizing advertised prices as opposed to sales prices. Recording companies claimed that some electronic and mass merchant stores were setting low prices of popular CDs to attract customers into their stores, thereby undercutting specialized music stores that provided services such as listening stations, in store advice, and promotional events. Those services resulted in an increase of music sales that was allegedly essential to the music business. The case was finally settled in 2003 for $143 million and the practice of establishing a minimum advertised price was terminated. 16 It remains a useful illustration of an alleged attempt by manufacturers to prevent aggressive price competition at the retail level that appears to have been dramatically decreasing the provision of services and sales effort. Of course, the per se status of RPM during that case meant that it was not necessary to show that consumers suffered harm as a result of the practice. Following Leegin, that will no longer be the case in the United States and as a result such cases will probably be far harder to prosecute in either public or private antitrust spheres. In Europe, in general the attitude to RPM is less permissive than the new legal regime in the United States. Specifically, in the EU, RPM is currently treated as a hardcore pricing restriction that is illegal unless the parties bring forward substanti- ated claims of efficiencies, that is, there is a “rebuttable presumption of illegality.” 17 One stated reason is that RPM is often associated with increasing prices. RPM can also be used as a facilitating device to cartelize retailers’prices because it effectively sets final retailer prices across retailers by way of a contract. What may look like a vertical contract may on occasion be a device for horizontal price fixing with neg- ative consequences for final consumers. The challenge for antitrust agencies under 14 In re Compact Disc Minimum Advertised Price Antitrust Litigation, M.D.L. no. 1361 (U.S.D.C. Me). 15 Leegin Creative Products Inc. v. PSKS Inc., Supreme Court of the United States, June 28, 2007. 16 District of Maine, In re Compact Disc Minimum Advertised Price Antitrust Litigation, M.D.L. Docket no. 1361 Litigation Decision and Order on Notice, Settlement Proposals, Class Certifications, and Attorney Fees. 17 RPM is considered an “object” restriction under Article 81 of the EC treaty (and its U.K. embodiment, the Competition Act, 1998). As a result RPM is viewed as harmful by object—that is, very likely to be anticompetitive so that a harmful effect may be presumed. 10.1. Rationales for Vertical Restraints and Integration 515 a rule-of-reason approach is to tell apart the efficient use of RPM from its potential far less benign use. 10.1.3.3 Exclusive Dealing Exclusive dealing, also called single branding, occurs when the upstream firm requires or induces the retailer to only sell its brand. There can be an explicit require- ment for exclusive dealing or alternatively such an outcome can be generated via a carefully designed pricing structure. For example, we may de facto see exclusive dealing if advantageous rebates are granted only to those retailers who purchase all their products from a single provider, the result will effectively enforce an exclusive dealing arrangement. There are, of course, many entirely valid substantial reasons that an upstream firm may want this type of contractual arrangement. One clear moti- vation may be a desire to protect their own investment in advertisement and quality by preventing retailers from steering consumers who arrive in the store to lower- priced, less well-known rival products once the consumer is in the store. Retailers might have an incentive to do so if rival products were able to provide retailers with higher margins despite lower sales prices, for example, because few advertis- ing costs were incurred. Thus exclusive dealing may solve a horizontal externality across producers within the retailer. A related example may arise if a manufacturer invests in its distribution channels to increase the level of service and promotional activity. It is possible that a retailer might choose to use these skills or resources to promote products from other producers. The contract in that case provides a mech- anism for the retailer to credibly commit not to engage in such activity and thereby provide the manufacturer with incentives for promotion to the potential benefit of both firms and also quite probably consumers. On the other hand, exclusive dealing may also provide a mechanism for foreclosure. 18 10.1.3.4 Tying and Bundling Tying and bundling are also ways in which manufacturers can condition the deci- sions of retailers downstream. These practices consist of conditioning the sale of a good on the sale of another, usually complementary, good. This can be done, for example, through a contractual obligation or because the pricing structure renders it unprofitable to purchase the two goods separately. An example might be aircraft engines and aircraft instrumentation. There is a large body of literature analyzing the reasons for tying and bundling. The explanations range from quality concerns to price discrimination and of course simple transaction cost advantages. Bundling can also be motivated by potential economies of scale and scope in production or distribution that allows the firm to 18 See, in particular, the foreclosure models discussed by Salop and Scheffman (1983), Comanor and Frech (1985), Schwartz (1987), Mathewson and Winter (1987), Rasmusen et al. (1991), Bernheim and Whinston (1998), Segal and Whinston (2000), and Simpson and Wickelgren (2007). 516 10. Quantitative Assessment of Vertical Restraints and Integration lower prices and increase sales by bundling the sales of several products. In theory, tying complementary goods can increase the incentives to lower prices since the firm will benefit from the increase in the demand of the initial product and also the tied product. In the case of metering and price discrimination, the outcome is less clear and will vary across customers. Although tying can have many nonexclusionary motivations, it can nevertheless also lead to intended or unintended foreclosure on the market. Whinston (1990) and Nalebuff (1999) among others analyze the incentives to tie and present conclu- sions for stylized examples involving assumptions about the consumer valuation of the tying product, the link between the valuations of the tied and tying products, and the nature of competition in the tied market (see also Bakos and Brynjolfsson 1998; Carlton and Waldman 2002). Whinston (1990) illustrates that a monopolist can, under some circumstances, profitably foreclose a market by tying and thereby commit to a low price for the bundle. His results also show that even though tying complementary products is less “costly” for the firm, the incentives to tie are also less obvious unless some particular conditions are fulfilled. Nalebuff (1999) shows that with heterogeneous preferences, bundling for complementary products can be profitable and foreclosure can be achieved. In a dynamic market characterized by innovation tying can also be used to weaken or foreclose potential competitors (Choi 2004; Carlton and Waldman 2002). This literature contrasts sharply with the position taken by the Chicago school, who heavily critiqued what they called “leverage theory.” Proponents of that view argued that if a firm had a monopoly in one good but faced competition in a sec- ond complementary product and consumers desired the goods in fixed proportions, then a “one-monopoly-profit” argument holds. Specifically, the monopolist in the first product need not monopolize the second market to extract monopoly profits. Two recent empirical papers consider variants of this debate. Chevalier and Scott Morton (2008) consider a horizontal version of the one-monopoly-profit argument arising from tying casket sales and funeral services together and their results favor the one-monopoly-profit argument. However, Genakos et al. (2006) find evidence that incentives for foreclosure exist empirically, looking at Microsoft’s incentive to leverage its monopoly in the “client operating system market” (aka regular Win- dows) to the “server operating system market” (aka Windows for network servers). In particular, they find that an incentive to leverage market power can exist provided perfect price discrimination is not possible for a monopolist. If so, then leverage can become a method that can help a monopolist to extract more rents from the monopoly market. 19 19 In support of their theory the authors report that in 1997 Microsoft’s Chairman Bill Gates wrote in an internal memo: “What we’re trying to do is to use our server control to do new protocols and lock out Sun and Oracle specifically. . . the symmetry that we have between the client operating system and the server operating system is a huge advantage for us.” 10.1. Rationales for Vertical Restraints and Integration 517 10.1.3.5 Refusals to Deal There exist cases of straight refusal to deal whereby a firm upstream simply refuses to supply a firm downstream that wants its output as an input. The legal treatment of this type of conduct varies under different jurisdictions. Increasingly, the goal of protecting the incentives for innovation and large upfront investments is balanced against the benefits that an access to the input would generate through a more intense competition downstream. In general, refusal to deal is unlikely to be regarded as a problematic action unless the upstream firm has some degree of market power. One important source of upstream market power may arise from the fact that a firm operates an essential facility. A deepwater port is an example of something that may be considered to be essential facility. A country may, for instance, have only one or two deepwater ports suitable for handling large cargo vessels. Entry, building a new port, is fairly obviously costly and may be impossible depending on geography, while transport costs for goods within a country may mean a given port owner has substantial market power. The difficulty for antitrust authorities is that there will also be cases in which the firm stops supplying a downstream firm with which it was previously trading for perfectly legitimate reasons. The termination of a relationship with a firm downstream may occur because the supplier thinks the intermediate firm is not keeping up with quality standards or otherwise not fulfilling aspects of an explicit or implicit contract. It may also be the result of changes in market conditions that affect the incentives of the firm upstream, for instance, changes in costs meaning that marginal units become loss-making. Clearly, even a dominant firm should not be forced to sell goods at a loss if economic efficiency is our aim. Thus, an antitrust authority must attempt to distinguish “legitimate” refusals to deal from illegitimate ones. Quantification of the effect of refusals to deal are generally quite difficult and involve comparing the outcome of a world where a business exists with one where the business does not exist. Perhaps as a result, to date, the assessment of refusal to deal cases has therefore been primarily qualitative in nature. 10.1.4 Effects of Vertical Restraints on Market Outcomes To summarize this first section of the chapter, the theoretical effect of vertical restraints on consumer welfare is, in many cases, ambiguous. On the one hand there are numerous potential motivations for vertical restraints that are entirely innocent and unlikely to cause legitimate concern to antitrust authorities. On the other hand vertical restraints may also facilitate outcomes that should be of concern to agencies seeking to make markets work well for consumers. Vertical restraints can sometimes be used as mechanisms to soften competition. In extreme cases the incentive to com- pete on prices can be entirely eliminated by the existence of such restraints. In other cases, vertical restraints may result in foreclosure of either inputs or customers. The bottom line is that economic theory does not allow general conclusions about whether vertical restrains are “good” or “bad” for welfare. In any given instance 518 10. Quantitative Assessment of Vertical Restraints and Integration the question is an empirical one, which means the competition authorities must first attempt to determine the circumstances in which a vertical practice may be cause for concern and should therefore be the object of scrutiny. Second, they must attempt to evaluate whether or not the vertical restraint should be banned or restricted for the benefit of consumers. Because theoretical predictions are not always, or even usually, clear about the net effect of vertical contractual arrangements on either total or consumer welfare, there have been a limited but perhaps increasing number of attempts to empirically assess the effect of vertical practices in both the case and academic literatures. In the next section, we present a number of different methodologies that have been used to try to assess the effect of vertical restraints. In looking at each example we will strive to illustrate both the benefits and limitations of such exercises. 10.2 Measuring the Effect of Vertical Restraints In the first section of this chapter we established that the motivations for vertical restraints are many and also that the theoretical predictions regarding the effect of these practices on welfare are often ambiguous. Sometimes a vertical restraint will solve an important externality problem to the benefit of both firms and consumers. On other occasions, it is exactly the externalities that drive good outcomes for consumers and so removing them via a vertical restraint generates poor outcomes for consumers. An example is when a vertical restraint acts to remove the horizontal pricing externality between firms, the one that usually means that competition leads to low prices and high-quality goods. Sometimes the ultimate goal of the practice is outright foreclosure and the result may be higher prices and lower output with no concomitant efficiency gains. On other occasions, the two effects will cumulate. Empirical analysis is a way to try to determine the effects of vertical restraints on consumer welfare in a particular case. Unfortunately, precisely because many of the effects we are trying to isolate are difficult to measure, it is particularly difficult to undertake an effects-based analysis of vertical restraints. Empirical strategies that have been used to determine the effects of vertical arrangements include regression analysis, particularly fixed- effects regressions, natural experiments, and event studies. Each is familiar from elsewhere in the book. However, it is important to note that such methods can only potentially help solve identification issues when there are data available on the situation with and without the practice. Ex ante analysis requires the construction and estimation of a structural model, which is very difficult to do without making stringent and quite possibly unrealistic assumptions about firm behavior. We discuss each of the available strategies in the rest of this chapter. Before doing so we briefly discuss informal and semiformal quantitative methods for evaluating the incentive for foreclosure. 10.2. Measuring the Effect of Vertical Restraints 519 10.2.1 Informal and Semiformal Analysis of Incentives Informal quantitative analysis can sometimes be insightful for evaluating the incen- tive for foreclosure. An example of such an analysis was provided involving a merger between English, Welsh and Scottish Railway Holdings (EWS) and Marcroft Engi- neering (Marcroft). EWS is a freight haulier on the railways, whereas Marcroft was a provider of railway maintenance services mainly serving the rail freight industry. The United Kingdom’s Office of Fair Trading (OFT) in its phase I investigation con- sidered whether EWS would have an incentive to foreclose access to the Marcroft maintenance depots since by doing so it could potentially harm its competitors in the downstream rail haulage market. To evaluate this option the OFT considered (1) the potential returns in the downstream market to foreclosure and also (2) the cost of foreclosing access to the Marcroft maintenance facilities. The OFT decision document notes from company accounts and information provided by third parties that both volume and profit margin are lower in the upstream maintenance market than they are in the downstream freight haulage market. 20 Assuming the margins do not change, a rough calculation of the incentive to foreclose would involve an evaluation of loss in upstream profits from maintenance Profit Maintenance D Margin M Volume M against the gain from higher downstream profits from haulage Profit Haulage D Margin H Volume H : Obviously, even these simplified expressions involve changes in volume rather than the levels of volume, but the OFT may have believed that the expected changes in volume would be reflective of the overall levels of each activity. Thus, since Margin H > Margin M and if Volume H > Volume M H) Volume H >Volume M : Then Profit Haulage D Margin H Volume H >Profit Maintenance D Margin M Volume M : Obviously, such a rough calculation involves some very strong assumptions as are appropriate for an authority exploring whether there is the potential justification for further investigation. In the end the OFT decided to refer the merger to the U.K. Phase II merger body, the Competition Commission, but decided that since it had also found potential horizontal problems with the merger, it did not need to come to a final view on the potential vertical concerns. In the end the CC accepted 20 See, in particular, paragraph 43, OFT decision document available at www.oft.gov.uk/shared oft/ mergers ea02/2006/railway.pdf. 520 10. Quantitative Assessment of Vertical Restraints and Integration undertakings from the company involving the divestment of part of the Marcroft maintenance business. 21 In 2008, the European Commission investigated a vertical merger involving the upstream market for the databases that allow the construction of navigable digital maps (NDMs) and the downstream market involving various electronic navigation devices. 22 Specifically, TomTom, a producer of personal navigation devices (PNDs), proposed a merger with the navigable digital map database provider TeleAtlas. 23 Public documents do not allow a complete reconstruction of the calculations per- formed to evaluate the total foreclosure story considered by the Commission, but nonetheless exploring the example is instructive. The vertical arithmetic approach suggests that to evaluate the plausibility of either a total or partial foreclosure theory of harm, the competition agency should evaluate the loss of profit upstream and the potential gain in profit downstream. Doing so allows an evaluation of the incentive to engage in foreclosure. Under a total fore- closure strategy, the vertically integrated firm will lose profits upstream because it stops selling to the “merchant market”—those firms competing with its downstream subsidiary. That means those rivals will face higher costs because, according to the theory of harm, they will have to buy from rival upstream suppliers who no longer face competition in supply and so will raise prices. In the TomTom–TeleAtlas case this total foreclosure theory of harm amounts to TeleAtlas deciding to stop compet- ing for the custom of rival PND companies that need navigable maps to build their navigation devices. As a result, TeleAtlas’s rival Navteq would face a reduction of competition and be able to increase prices (or more generally follow some other strategy such as reduce quality). 21 See www.competition-commission.org.uk/inquiries/ref2006/marcroft/index.htm for further details. 22 We willnotdivert our discussion withadetailedevaluationofthevarious marketdefinitions.However, we do pause to note there that the Commission came to the view that: (1) Upstream there was demand-side substitution between the navigable digital maps provided by TeleAtlas and Navteq. However, there was no demand-side substitution between navigable maps and more “basic” digital maps which could not be used for real-time navigation while driving your car. Moreover, the Commission received estimates that it would take something like 1,000–2,000 people five to ten years to upgrade a basic map to the quality of a navigable map. Thus there was neither demand nor supply substitution. Geographic markets upstream were left ambiguous as they were judged not to affect the conclusion of the analysis. (2) Downstream, the Commission noted that there were various forms of navigation devices: personal navigation devices (in the form of a handheld device that you could put in your car), maps on personal digital assistants, “in-dash” navigation devices (navigation devices built into car dashboards), and GPS enabled mobile phones. The Commission after looking at the evidence decided that PNDs constituted a downstream market in itself. 23 See Case no. COMP/M.4854 TomTom/TeleAtlas. At around the same time Nokia (the mobile phone producing company) merged with TeleAtlas’s main rival navigable map producer, Navteq. (See Case no. COMP/M.4942 Nokia/Navteq.) Both mergers were ultimately cleared. The analysis undertaken in these mergers was widely seen as testing the European Commission’s latest vertical (nonhorizontal) merger guidelines, which were adopted in November 2007. The new set of guidelines was developed partly in response to criticisms from the Court of First Instance following the European Commission’s controver- sial decision to block the proposed merger between GE and Honeywell. (See Case no. COMP/M.2220 General Electric/Honeywell.) 10.2. Measuring the Effect of Vertical Restraints 521 Downstream rivals Merging firm P TT R Rivals ( p TT ; c 0 ) P Rivals R Rivals ( p TT ; c Higher ) R TT ( p Rivals ; c Lower ) R TT ( p Rivals ; c 0 ) E 1 E 2 E 1 = Start E 2 = Finish Figure 10.1. The impact of a vertical merger on own and rivals’ costs. In effect, a vertical merger followed by input foreclosure by the vertically inte- grated firm would mean that (1) TomTom’s competitors in the downstream market would face higher input costs following the merger while (2) TomTom itself, as the downstream division of a vertically integrated firm, would be able to reduce its costs if vertical integration has aided the reduction or avoidance of double marginaliza- tion. In the case of TomTom–TeleAtlas we know from the Commission’s decision document that pre-merger upstream gross margins were high, approximately 85%. The reason is that developing a digital map involves a great deal of essentially fixed- cost investment while the resulting database can subsequently be duplicated at low marginal cost. That means that if pre-merger vertical contracting was not able to solve the double marginalization problem, then TomTom’s (TT’s) marginal costs could decline considerably post-merger. At the same time, rival downstream firms would, according to the theory of harm, face higher input costs as they would now suffer from a lack of competition upstream. Figure 10.1 presents the impact of vertical integration when it (1) reduces dou- ble marginalization for the merged firm and (2) increases marginal costs for rivals because the merged firm follows a foreclosure strategy. The former effect shifts TT’s reaction function downward while the latter effect shifts the rival’s reaction function rightward to reflect an increase in input costs (for any given price of TT, rivals will now choose to charge a higher price). Figure 10.1 shows that the impact of such a change on downstream competitive outcomes can involve lower prices for the vertically integrating firm as well as poten- tially higher prices from its downstream rival(s). Naturally, the aggregate welfare impact of such a change will depend on the relative magnitudes of the consequent profit and consumer surplus gains and losses. It is this observation that induces many agencies to choose a framework for vertical merger analysis which includes an analysis of ability, incentive, and consumer harm. That said, those competition agencies whose statutory framework do not immediately “net-off” consumer sur- plus gains and losses will note that some customers have lost out under a merger 522 10. Quantitative Assessment of Vertical Restraints and Integration P TT R Rivals ( p TT ; c 0 ) P Rivals R Rivals ( p TT ; c Higher ) R TT ( p Rivals ; c Lower ) R TT ( p Rivals ; c 0 ) E 1 = Start E 2 = Finish E 1 E 2 Figure 10.2. The impact of a vertical merger on own and rivals’ costs (2). that led to this outcome, even if ultimately overall consumer welfare is higher, per- haps because the vertically integrating firm has a far larger share of the market who benefit from lower prices post-merger. Figure 10.2 shows that when the integrating firm benefits from removing dou- ble marginalization are small relative to the magnitude of the effect of increased costs suffered by rivals in the downstream market, the outcome will tend to involve the prices charged by all firms increasing. Such an outcome would clearly be unambiguously bad for consumers, all else equal. Taking some data from the TomTom–TeleAtlas case, according to the case docu- ments, there were unit sales of 10.8 million NDMs for PNDs with an average selling price of €14.6. Moreover, pre-merger TeleAtlas sold their database to TomTom and also to other downstream producers, who accounted for between 10 and 30% of the downstream market, 24 that is, between 10:8  0:1 D 1:1 and 10:8 0:3 D 3:2 million units. TomTom’s downstream rivals include Garmin, Mio-Tech & Navman, Medion, and My Guide. Since the case tells us that gross margins were 85%, a foreclosure strategy would involve sacrificing profits (or at least a “contribution” to upstream fixed costs) of between €14:6  1:1  0:85 D €13:7 million and €14:6  3:2  0:85 D €39:7 million. To simulate the potential gain downstream, in principle we could analyze the static downstream game and then make reasonable assumptions about the changes in costs that TomTom and also rivals were likely to experience following a merger and a decision by the vertically integrated firm to pursue a foreclosure strategy. This was the type of calculation undertaken by the European Commission. Unfortunately, there is not sufficient information in the public domain to repeat the Commission’s simulation exercise, but the reader familiar with the analysis of the differentiated product Bertrand pricing game presented in chapter 8 will be able to see exactly how 24 Only a range is available in the public decision document. [...]... country The intention was to promote within-brand competition (across dealerships) both within a country and across countries in the European Union 30 For closely related models of vertical competition, see also Dubois and Bonnet (2008), Villas-Boas and Zhao (2005), and Villas-Boas (2007a,b) 31 For a structural analysis of exclusive dealing using similar techniques to those described in this section,... 1 j ; g exp.Iig /; gD1 and hg and g are the nesting parameters which are allowed to vary for the different groups and subgroups As always, aggregate demands for a given product are calculated by integrating over the demands of each consumer type, here yi Thus, predicted sales for a given product are the weighted average of individual choice probabilities where the weights are by the density of the... vertical integration with a and qualities since some people will have only basic services and some people will have both basic and premium Heterogeneous demand also may complicate the calculation of consumer welfare since there is no longer one single demand curve That said, in fact the issue may fairly easily be solved, at least in principle, by (for example) estimating demand curves for the various major... results hold once we control for other factors that affect demand and supply, and that could potentially also be spuriously correlated with the ownership structure The approach will be familiar from earlier chapters and involves running a reduced-form regression of the equilibrium outcome (e.g., price or number of channels) on demand and cost factors as well as an indicator variable for vertical integration... defined as the area below the demand curve (see the discussion in chapter 1) If we have information on prices and qualities with and without vertical integration, we can compare the two situations and examine the effect of vertical integration on consumer surplus Chipty (2001) estimates a demand system (illustrated in figure 10.4) with two demand functions, one for each of basic and premium cable The variable... calculation does not make a clear case for or against the incentive for total 524 10 Quantitative Assessment of Vertical Restraints and Integration foreclosure, such a calculation can help us to explore which alternate assumptions (e.g., about captured market share, downstream margins and how they are likely to change, and pass-through rates) that would provide grounds for either concern or reassurance... proof is on the competition agency to establish the harm likely to be caused by a merger and, if so, this calculation would suggest that burden of proof would not be discharged Obviously, we have made a lot of assumptions in this rough calculation and a more careful calculation would get closer to real numbers for the potential upstream losses and downstream gains from foreclosure For now we note that... approximate calculation requires that the utility provided by basic and premium cable is additively separable for consumers This means that an increase in the utility obtained from basic cable does not affect the utility obtained from premium This assumption would probably be wrong if, for example, we were considering the demand for beer and pizza and consumers usually found pizza more enjoyable with a... out toward the right, for any given price we will tend to generate higher estimates of consumer surplus, although the amount of consumer surplus could easily be reduced if consumers faced high prices in those markets Crawford (2000) provides an alternate model of demand for basic and premium cable using a similar data set allowing for consumer heterogeneity while Shum and Crawford (2007) add a supply... potential endogeneity concerns that may arise due to the fact that vertical integration and the number of channels are both decisions made by the firm Naturally, it may be very difficult to find an appropriate instrument for vertical integration and Chipty’s reduced-form results are therefore subject to the standard and potentially important endogeneity critique that Hastings (2004) hopes to avoid with . 519 10.2.1 Informal and Semiformal Analysis of Incentives Informal quantitative analysis can sometimes be insightful for evaluating the incen- tive for foreclosure. An example of such an analysis was. Before doing so we briefly discuss informal and semiformal quantitative methods for evaluating the incentive for foreclosure. 10.2. Measuring the Effect of Vertical Restraints 519 10.2.1 Informal. and Winter (1987), Rasmusen et al. (1991), Bernheim and Whinston (1998), Segal and Whinston (2000), and Simpson and Wickelgren (2007). 516 10. Quantitative Assessment of Vertical Restraints and